Measuring Economic Growth and Performance
Measuring Economic Growth and Performance
Edward D. Lotterman,
One of the key tasks for principles students is to learn how important economic parameters such as GDP, inflation, and unemployment are defined and measured and why such measures are important to policy makers and laypeople as well as academics. I have found it helpful to use an analogy that compares these economic variables to the physiological ones a physician might record while examining a patient. GDP is to a nation as height and weight are to a person. The rate of change in the price level bears some similarity to body temperature; interest rates may be compared to blood pressure, and so on. The comparisons may seem a bit farfetched, but they do provide an intuitive understanding of why these economic indicators are measured and recorded. These indicators give government, business, and the general public some idea about what economic actions might be advisable just as key physiological indicators give physicians some basis for actions with regard to their patient's health.
I extend this analogy when I deal with less important indicators such as housing starts. I note that these are not necessarily important in themselves, but are valuable because they serve as proxies for more important factors or because they give advance warning of possible changes in more general economic conditions. Then I tell them about a physical exam I had some time ago. The doctor felt my feet and toes. He said, "Hum that's funny, I just can't find a pulse anywhere in your toes." He felt again and then said, "Well, in any case you have good hair growth on them, so it should be OK." Mystified, I asked my doctor why such minor things as pulse or hair growth on toes were of any interest. It turns out that poor blood circulation is one of the leading indicators of the onset of diabetes, and that deteriorating circulation in the toes is a sign that any good clinician looks for. Not finding a pulse is a sign of possible poor circulation which might warrant further tests, but good hair growth indicates that circulation is not a problem. This simple analogy can be understood by most students and it reinforces the understanding that many variables, while not of overwhelming importance in themselves, can nevertheless be important indicators about the state of other aspects of the economy.
Denny Myers,
Have your students investigate which country in the world has the
highest per capita DPI. You will get many answers, but one should be the island
COMPUTING A PRICE INDEX AND REAL OUTPUT
Knowles R. Parker,
To
better understand a price index or a table comparing current GDP and real GDP,
students should have a crack at computing these numbers. The trouble is that when even a hypothetical
price level is put up on the board as a starting point, there is only the
assurance that at least one student will do the original computations. Nominal students will make a last minute
effort to avail themselves of the work accomplished by the one real
student. How to individualize?
Here's how it works. The price level for a nine year period is unique to every student, because the units digit in each of the three digit numbers representing the price level is the student's social security number. The first two digits are 50_ through 58_ (or really any other sequence). It's arbitrary, but the fifth year can be designated as the base year and given the index value of 100. From this beginning each student must follow the procedure for computing the price index as explained the most text books.
The table can be extended, using the same data, to figure the inflation rate. By designating an actual or units output of 100 through 108 (or any other sequence), the exercise can include calculations for current output and real output in dollars, using the price index as the deflator.
In the discussion that follows students can refer to their own tables to clearly see that the increase in current output in dollars reflects both the increase in the quantity of goods and services and the price tags put on them.
Such an assignment is quickly graded, and the instructor can harbor a lot less suspicion that he or she is going through a stack of facsimiles!
CREATING AND USING A PRICE DEFLATOR
PRICE PRICE INFLATION ACTUAL CURRENT REAL
YEAR LEVEL INDEX RATE (%) OUTPUT OUTPUT($) OUTPUT
_______________________________________________________________________________
1 502 92.79 2.19 100 50200.00 54100.66
2 513 94.82 2.73 101 51813.00 54643.54
3 527 97.41 1.52 102 53754.00 55183.25
4 535 98.89 1.12 103 55105.00 55723.53
5 541 100.00 2.96 104 56264.00 56264.00
6 557 102.96 1.44 105 58485.00 56803.61
7 565 104.44 1.06 106 59890.00 57343.93
8 571 105.55 2.10 107 61097.00 57884.41
9 583 107.76 108 62964.00 58429.84
Table 8-1
Profits in National Income Accounting
Thomas J. Shea,
In any national income accounting problem, students invariably confuse the separate terms "undistributed corporate profit," "corporate profits taxes," and "dividends" with the total term "corporate profits before taxes." They will sum two, three or all four terms. Draw the parallel that the breakdown of the three separate terms is similar to the difference between gross earnings and take‑home pay. Just as we know that a paycheck before taxes is not indicative of what workers get to keep and that we must use different terms to distinguish them, it is the same with corporate profit before taxes. By asking what happens to paychecks, you get responses about how state taxes, federal taxes, FICA, etc. are taken out and distributed to various agencies, you tell them to imagine that "corporate profits before taxes" is a corporation's paycheck. What happens to it? Some is "distributed" to the government in the form of taxes; i.e. "corporate profits taxes." Some is distributed to the stockholders; i.e. "dividends." Finally there is the part that is left in the corporation; i.e. "undistributed corporate profit." The sum of the parts equals the whole.
Gross Investment minus Depreciation
Lee J. VanScyoc, University of Wisconsin-Oskosh
Students often find it difficult to comprehend why the capital consumption allowance should be subtracted from GDP. I find the following example aids in a simplistic manner to explain why.
Let's
assume that on
Has national welfare increased by three houses compared to the number of homes as of January 1? Column 3 shows that the economy is only 2 houses better‑off and not 3 houses. Why only 2 houses and not 3? One of the new houses simply replaced house #5 (the one destroyed by fire), so gross investment (3 houses) minus capital consumption allowance (1 house that burnt) equal net investment (2 houses). Thus, net investment is a better measure of national welfare.
Figure 8‑1 Gross Housing Investment after Rapid Depreciation
David Jones,
Suppose
that this class represents all
Here's the question: Did the rental component of GDP derived via the income approach (W + R + i + P, etc. ) rise in the one year of craziness? If it did, how was that accounted for in the expenditure measure of GDP (C + I + G + X ‑ M)? It must have been caught by C, as consumption of housing services. When we all "move back home" reported rent falls, but does the consumption of housing services? Don't we continue to get the same C out of our houses, just without paying rent to anyone else? It would seem that GDP from the expenditures side has not changed. Its just a question of whether I am consuming the services of my house or my neighbor is. This implies that there would be no difference in the income measure of GDP either. (If you don't change C + I + G + X ‑ M, you can't change wage + rent + interest + profit, etc!) The folks at the Department of Commerce account for this apparent paradox by imputing rent to home owner/occupants (i.e., estimating the rental value of all the owner occupied housing and including that in the rental and consumption of components of GDP.
How Do Imported and Used Cars Affect GDP and NNP?
David Jones,
Consider an imported car. Where was it produced? Say,
Now let's
look at a
After the car is built, as it sits
in
We've already dealt with resale of a used car. But there is one other way that this car can affect future national income and product accounts: Depreciation. If the car was exported, it's gone. If it was bought by a consumer, its not used in the production of future goods and services (in the eyes of Department of Commerce), so it's not depreciated. Even if the government bought it and used it to taxi VIP's around, it's not considered to be additionally productive (maybe Commerce is right!) and it's not depreciated. Only if a business owns the car (say, a taxi company) does it affect future national and product accounts, by lowering NNP relative to GDP due to its depreciation.
Ralph T. Byrns
Students seem to enjoy discussing the limitations of GDP estimates. Be sure to point out that errors in GDP accounts can lead to improper policy making (just as business decision makers faced with bad information about costs, sales, profits, etc., will make poor decisions.) Then ask your students why the rental value of owner occupied housing is included in GDP, and how accurate they think these figures are. List several types of data, and ask them to rank it for accuracy. E.g.:
a. Value‑added sales data from General Motors.
b. Tips reported by waiters and waitresses.
c. Wages earned by government employees.
d. Values of food grown and consumed on the farm.
e. Gross sales from home repair firms.
f. Sales people's incomes after adjusting for business expenses.
Many
students will conclude that the data are so erroneous that GDP measures are a
waste of time. Remind them (from Chapter 5) that the bulk of reported
production and sales in this country are channeled through giant corporations
that are closely scrutinized by the IRS. Suggest that this implies that either:
(a) the dominance of giant corporations in the
In a similar vein, students are very interested in the Underground Economy. Ask students if they know people who fail to report all of their income to the IRS, or who overstate their personal deductions and business expenses. This almost always generates a lively class discussion.
A different ploy is to ask students how many have had a course in statistics. After a show of hands, discuss the standard statistical assumption that measurement errors are off‑setting (normally distributed). Then ask the class whether they believe that reported incomes are as frequently overstated as they are understated. Students quickly see the point, and its implications for national income accounting.
Emphasizing the Concept of GDP
Ralph T. Byrns
Students should be able to distinguish between conceptual GDP (the total value of annual production) and published estimates of GDP, which are severely limited by data availability. If you shine your own shoes, for example, this adds to conceptual GDP, but not to measured GDP. You might relate the old tale about the man who marries his maid and, thus, reduces measured (but not conceptual) GDP.
Many students do not understand why imports are subtracted from exports. (ANSWER: Because imported goods are included in consumption, investment, and government purchases.) Challenge students to think of any other groupings of buyers. Ask them to explain why transfer payments are not included in government purchases. (ANSWER: Nothing must be produced by welfare recipients for them to receive these payments. This is not the case for consumer or investor transactions, nor for government purchases. For these transactions, there is always quid pro quo.) We find that emphasizing the concepts by raising such questions is more effective in developing student understanding than is spending a lot of class time on accounting examples.